Can Hortonworks Improve Its Profits In Tandem With Revenues?

The company's losses, however, expanded by a large margin due to high S&M costs

Hortonworks appears to have good growth runways in the Hadoop space, though the company's rise might not come as easy as Red Hat's

The highly competitive nature of the industry means that profits for Hortonworks might be elusive for a long time

Shares of leading Hadoop products vendor Hortonworks (NASDAQ: HDP) have soared 14% after the company handily beat on second quarter revenue and EPS estimates. Hortonwork’s revenue and billings grew in triple digits--revenue grew 154% Y/Y to $30.7 million while billings were up 114% Y/Y to $41.8 million. Hortonwork’s gross profit improved 218% to $17.5 million. The company’s net loss, however, expanded 57% to -$42.3 million, or EPS of -$1.00

Source: CNN Money

Hortonworks business model

Hortonworks is a company that deals in Apache Hadoop products. The company was once part of Yahoo (NASDAQ:YHOO), but was spun off in 2011. Hortonworks became a publicly-listed company in 2014. Hadoop is a Big Data processing and storage framework that organizations use to analyze massive swathes of data. Apache Hadoop is an open-source framework, that was developed by Yahoo engineers based on Google’s (NASDAQ:GOOGL)(NASDAQ:GOOG) File System and MapReduce. Being a company built around an open source platform makes Hortonworks’ business model quite similar to that of Red Hat (NYSE:RHT). Hortonworks does not sell Hadoop directly, but rather makes money by offering support and subscription services for companies that need a helping hand to run their Hadoop projects. Running a large Hadoop project with several hundred or thousands of nodes can be very labor and cost intensive for a company, requiring a large input of IT resources. Many of Hortonworks’ engineers are responsible for having developed the original framework back at Yahoo, and have thus accumulated unique insights into the platform that many organizations’ IT departments lack. This is Hortonworks’ strongest selling proposition.

But, Hortonworks is not without competition--Cloudera, MapR Technologies, Altiscale, Qubole, among other companies, sell pretty much the same thing, the big difference being that Hortonworks is a purist that peddles the original Hadoop straight from Apache’s trunk. Several leading cloud vendors offer Hadoop in one flavor or the other. Amazon’s (NASDAQ:AMZN) AWS offers Elastic MapReduce, or EMR, while Microsoft (NASDAQ:MSFT) has Azure HDInsight.

There is little doubt that there is a growing market for Hadoop. The platform helps create insights into customer activity and new monetization opportunities through a central architecture. Many organizations suffer from data overload that comes from too much data spread over segregated silos. Hadoop allows these organizations to aggregate all their disparate data and create a common language for it.

So just how big is the Hadoop market? Wikibon pegged the Big Data market at $27 billion in 2014, and predicted it would reach $60 billion by 2020.

Source: Wikibon

More and more organizations are now exploring Hadoop.

Source: GigaOM

Quantifying the actual Hadoop market is a little bit more difficult. Hadoop vendors can make money through a software license model, or by selling Hadoop-as-a-Service, or by selling Hadoop embedded in other products. Hortonworks makes money by getting support subscriptions for both cloud and on-premise nodes. The largest organizations are the ones most likely to buy Hortonworks’ Hadoop support services due to their scale. These are organizations that run hundreds or thousands of Hadoop node clusters. A single node cluster could be licensed for about $2,000 per year. A company running 1,000 node clusters will therefore fork over $2 million for support services. If 75% of Global 2,000 companies adopt Hadoop by 2020, then you are looking at a $3 billion market.

Assuming Hortonworks’ open source Hadoop model allows the company to dominate the industry just like Red Hat has done with open source Linux, and grabs about half the Hadoop spend by 2020, then the company will have to grow its current revenue at about 65% CAGR through 2020. Right now the company’s growth trajectory appears well aligned to achieve that target. But there is a bigger problem looming for Hortonworks.

Ultra High Selling&Marketing Costs

Looking at Hortonwork’s latest quarterly report, one thing becomes abundantly clear: Hadoop is far from being an easy sell. During the last quarter, Hortonworks spent $33.31 million, or 108% of revenue, on selling and marketing expenses. In other words, the company spent more money on marketing expenses than it made from selling its products, and that’s not counting other operating expenses. This is clear proof that the Hadoop space is intensely competitive, and Hortonworks has to fight for every dollar that it gets. Very high marketing expenses were responsible for pushing the company deeper into the red.

Red Hat has always been profitable since its early years, probably because back then not many people believed that a company could make money on an open source model. But this perception has now changed and there are more companies than ever that are looking to build their businesses around the model. Hortonworks has nabbed a number of high-profile customers such as Microsoft, EMC (NYSE: EMC) and Rackspace (NYSE:RAX). The company renewed its 3-year contract with Microsoft’s HDInsight in June. Clearly Hortonworks has earned the trust of some industry heavy hitters. But I don’t think its journey is going to be as easy as Red Hat’s. Red Hat made history when it became the first $1-billion dollar open source company. Hortonworks could very well become the second company to do so, though its path is bound to be rocky. Opening a long-term position in the company at this point is fraught with risks. Investors should probably wait and see if the company’s bottom line can improve in tandem with its top line.

Cloudera which is expected to go public this year, is the biggest pure play Hadoop developer, with a valuation of $4.1 billion as of March 2014. The company earned more than $100 million in revenues in 2014, which is more than double the revenues of Hortonworks and MapR.

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AMD stock shot up by over 8% on Thursday on the back of a double upgrade by BoA. AMD stock is now up by nearly 50% over the last 30 days. Technical indicators suggest that AMD stock is entering overbought territory. But is it really?Shares of Sunnyvale, California-based

Micron has introduced new Enterprise SSD which enables data storage platforms to meet all the demands for the data centers. SSDs have significant advantages over the traditional hard disk drive, while the cost difference is decreasing. The transition to all flash data center will benefit Micron which will see higher demand for its products and could drive its stock.

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